ABSTRACT
This chapter assesses how Modern Finance has contributed to the aggravation of financial bubbles by taking a closer look at three episodes in the 1980s, the 1990s and the 2000s. In Modern Finance, it is assumed that markets are always continuous and liquid. Portfolio managers identified market prices, which deviated from "fundamental" values derived with Modern Finance Theory, and placed bets on the disappearance of these deviations. Modern Finance supplied the necessary tools for the move. Perhaps bank and investment fund managers would have shied away from the debt pyramid made possible by credit securitization, if Modern Finance had not had another instrument for risk management in its quiver. One could have expected that the frequency of financial bubbles would have fallen as well with progress in economic science. The latter played a particularly important role in the financial crisis. The magic formula for the management of risk remaining in the financial institutions was called "Value-at-Risk".
